By: Paul Morrone
Nearly 21 months of a bull run has made many investors forget about the 2022 recession and the pain that came along with it. Those that stayed the course through the turbulent bear market were rewarded for their perseverance – as is usually the case for long-term investors – as US equities (as measured by the S&P 500) rebounded and have notched nearly 3 dozen new highs in 2024 alone. Speaking of patience, looking back even further, the S&P 500 has more than doubled since its COVID lows in just over four years – a feat that takes, on average, 8-9 years (at least based upon historical rates of return). Needless to say, those that panicked and sold their equity holdings during the dark days of COVID lost out on significant appreciation – a painful lesson to learn with the benefit of hindsight.
But the S&P 500 doesn’t tell the whole story. Other areas of the equity markets have not seen performance nearly as strong. On the domestic side, for example, small and mid-cap equities have yielded only about 50% of the return of the S&P year-to-date. This contrasts with the data in our last quarterly update where mid-caps matched, and even outperformed, large cap stocks through 3/31/24. At the time, we had spoken about the broadening of the equity rally beyond the large (specifically mega-cap) space. Since then, however, momentum outside of the mega-cap names sputtered out and the performance of the extended market has been flat or even down over the past 3 months.
That’s not to say there isn’t a silver lining. By comparison, small and mid-cap stocks look cheap relative to their larger counterparts. Additionally, with the prospect of rate cuts on the horizon, smaller companies may benefit from a tailwind given their lower valuations. From an even more simplistic standpoint, investors understand that there are more than 4 or 7 companies to invest in, even if it seems otherwise at any given time. As the Fed’s path toward easing becomes clearer, investors may again reallocate their capital to other areas of the market that are waiting to breakout. The hope, then, is that a rising tide could lift all boats.
Many have accepted the ‘new normal’ investment climate, which has both striking similarities and stark differences with the post-financial crisis era from 2009-2020. On one hand, technology, communications and other growth equities continue to lead the charge into 2024 – a narrative we have become all too familiar with over the past decade or so. The concentration of performance, however, remains unique to this year with Nivida, alone, accounting for nearly a third of the S&P’s performance so far this year. Consistent with our previous commentary, we are watching closely to see whether market breadth can increase during the summer months and allow other areas of the market to catch up to the S&P 500.
Equities aside, arguably the bigger story has been within interest-rate sensitive investments such as fixed income. Whereas things looked promising early in the year, performance has remained virtually flat on a price basis for major fixed income indices such as the Barclays Aggregate bond index. A keen eye remains on the Fed and Chairman Jay Powell each time he takes center-stage. At the beginning of 2024, financial markets and many Wall Street analysts were predicting no less than 3 rate cuts by the end of the year, with the first one as soon as June. Hindsight tells more of the story, as real-time data showed less progress than the Fed would have hoped through the first half of the year in their continued fight to cool price appreciation. This has led investors to push their expectations for rate cuts back much further into the year (now markets are pricing in 1 rate cut in the 4th quarter). While we remain cautious to assume this is the case, the Fed remains very data-dependent and is closely monitoring real-time information for a greater level of assurance that the higher rate environment has had the intended effects on inflation on and the American consumer. Powell has remained steadfast in his messaging of higher-for-longer, and we believe it is likely that a rate cut will not occur until 2025. This aligns with our thesis from past quarters as we were never confident in rate cuts occurring in 2024.
Moving into the latter half of the year, we continue to remain watchful over several bullet points that that may impact our expectations as we move into the third quarter:
• Short-term price fluctuations – Given the rapid rise in prices, especially among the S&P500, it would not be unreasonable for a 5%-10% correction to occur. Contrary to the emotional impact of equity volatility, short-term corrections are indicative of a healthy market and economy and generally are not cause for long-term concern.
• Continued scrutiny of inflation, price wage and unemployment data – This has been part of our discussion over the past two years now and we continue to stress the importance of these trends.
• The upcoming Presidential election – a front-and-center concern for every American. While headline risks and a shock-outcome may have short-term impacts, equities have typically been agnostic over the long-term in terms of which party is in control of the presidency.
• The probability that there is a Republican or Democratic sweep across the House and Senate – this goes part hand-in-hand with the Presidential election, however, a sweep across all three could increase the likelihood that political or economic policies see a fast-track into effect.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
All investing involves risk including the possible loss of principal. No strategy assures success or protects against loss.
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